The Anatomy of a Settlement Agreement
Settlement agreements are an essential tool for employers. They allow workplace issues to be resolved efficiently, reduce legal and reputational risk, and bring certainty to both sides. But with major reforms coming into force over the next two years, particularly around NDAs and protected disclosures, employers must understand exactly how a settlement agreement should be structured and what each clause achieves.
This employer-focused guide breaks down the key components of a settlement agreement, highlights best practice and flags areas where organisations should proceed with caution.
Identifying the parties and setting the context
The agreement begins with:
- the employer’s legal entity
- the employee’s full name and job title
- the employment end date
- a neutral summary of the circumstances
Employers should ensure the correct employing entity is named. It may be necessary to set out whether the employer is entering into the agreement just on their own behalf or as agent and trustees for all group companies (and that they are authorised to do so).
When setting out the background to and context of the dispute, neutral wording is almost always the safest approach.
Schedules
Schedules are appendices placed at the end of the agreement. They contain detailed or lengthy information that supports the main agreement but would clutter the body of the document. Common uses include a schedule of payments, a schedule of waived claims, a schedule of post-termination restrictions, a copy of the Adviser’s Certificate and a schedule of property to be returned.
Termination date and all payments owed
This section should usually include details of:
Notice pay or Payment in Lieu of Notice (PILON)
Set out whether or not notice is being worked or paid in lieu. The employer must have an explicit PILON clause in the contract to make a payment in lieu of notice without being in breach of contract.
Outstanding salary and holiday pay
This must be paid at the correct rate.
The settlement sum
The main settlement figure should be clearly identified and separated from other payments. The first £30,000 is normally tax-free, but employers must take care with wording.
The settlement agreement should explicitly detail the breakdown of any redundancy pay, including how it was calculated based on the rate of pay and length of service. This is important because it separates this payment from other compensation and clarifies the specific amounts, dates, and any tax implications.
Other payments that may need to be accounted for include bonus payments (and how this is to be calculated), benefits payable, expenses and any share or stock options.
Legal fee contribution
Most employers will make a contribution towards the employee seeking advice on the agreement itself.
Payment timetable
It is good practice to specify exact dates or payroll cycles to avoid disputes and breach allegations. Mistakes in this section can invalidate the agreement or cause costly delays.
Waiver of Claims
There will usually be a clause stating that the employee/claimant agrees to waive all legal claims against the other party, such as their rights under the:
- Employment Rights Act 1996
- Equality Act 2010
There will often also be a clause stating that no further claims can be brought relating to the employment or dispute.
An employee cannot be asked to waive claims for:
- Enforcing the terms of the settlement agreement itself.
- Any personal injury that the employee is not or cannot be reasonably expected to be aware of at the date of the agreement.
- Accrued pension rights.
However, recent case law held that it is possible to settle claims that have not yet arisen or are not yet known about at the time of signing. It’s important to make it clear if this is what is envisaged.
Warranties and obligations
A settlement agreement usually requires the employee to confirm a series of warranties (assurances) and ongoing obligations to protect the employer after the relationship ends. These commonly include confirming that:
- They have not already brought claims against the employer and are not aware of any circumstances that would give rise to new claims, other than those being settled.
- They have not committed any serious misconduct or breached their contract in a way that the employer has not already been told about.
- They have not misused confidential information and will continue to keep it confidential after the agreement is signed.
- They will cooperate with reasonable post-termination formalities, such as handing over work, assisting with ongoing matters, or responding to later queries.
- They have disclosed everything relevant to the employer—for example, any outstanding expenses, grievances, or data subject access requests.
- They have not accepted another payment or benefit from the employer that has not been disclosed in the agreement (sometimes included to prevent double recovery).
- They will pay back the settlement sum if they later bring any of the claims they have promised to waive.
Independent legal advice (mandatory)
Settlement agreements are only valid if the employee receives independent legal advice. The agreement must:
- Name the adviser
- Confirm they are suitably insured
- Confirm they advised on the effect of the agreement
This is not optional and failure to include this wording makes the entire agreement unenforceable.
Confidentiality
Confidentiality clauses (often referred to as Non-Disclosure Agreements, NDAs or gagging clauses) must be carefully drafted. A confidentiality clause will usually be used to prevent disclosure of the settlement sum, the complaint and allegations, other circumstances concerning the end of the employment and sometimes sensitive business information. The confidentiality clause may also seek to include a term that prevents either party making disparaging comment about the other.
The Government plans to bring in new rules that prevent the use of NDAs to prevent individuals from discussing allegations of harassment or discrimination.
If and when the rules come into force, there will be limited circumstances known as “excepted agreements” where an NDA can still be used.
Restrictive Covenants
Restrictive covenants will still be permitted under the Employment Rights Act and employers may wish to use the settlement agreements to reaffirm existing covenants, clarify their scope and / or introduce new or updated covenants.
For a restrictive covenant to be enforceable, employers must show a legitimate business interest, and restrictions that go no further than necessary.
You can read more about this here:
No Admission of Liability
It is common for a settlement agreement to state that neither party admits fault or liability by entering the agreement.
Reference and announcement
The parties may also wish to agree the terms of an employment reference or a joint statement for external use.
Return of Property
The settlement agreement should set out what property needs to be returned and when by.
Tax Indemnity
It is also important to confirm that the employee is responsible for any additional tax arising if HMRC challenges the tax treatment.
Breach and Enforcement
The agreement should set out what happens if a party breaches the agreement (e.g., repayment of the settlement sum, injunction, or damages). Many agreements include clauses allowing employers to reclaim settlement payments if the employee materially breaches the agreement. Once again, careful drafting is required and clawback of part or all of the settlement sum should not be allowed for minor or accidental breaches.
Entire agreement and governing law
The agreement should conclude with an “entire agreement” clause, provisions on jurisdiction and governing law, and the necessary signature and execution requirements.
An “entire agreement” clause is a provision in a contract stating that the written agreement represents the full and final terms agreed between the parties. It confirms that any previous discussions, negotiations, promises or understandings, whether spoken or written, are not legally binding unless they are expressly included in the contract.
If you would like to discuss any of the issues raised in this article, please get in touch.
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